Peak SBC, LLC  



by: Cary Christian

There is data that suggests small businesses get into trouble more frequently than their larger counterparts. This is due, in part, to there being so many more small businesses than large businesses and how easy it is for almost anyone to start their own business.

But if we exclude the small startups that never had a chance to begin with, small businesses are often run far more efficiently than larger ones because talented owners are more involved in day-to-day operations and take more of a personal interest in the way the company is perceived both internally and externally.

When small businesses do get into trouble, the reasons are often very similar from business to business. The failures of larger companies are often highly publicized and other large companies tend to learn from the mistakes of their peers and take corrective action rather quickly. Small businesses are often not privy to the facts and circumstances of the demise of their counterparts, which are usually private organizations, and miss the opportunity to learn from the mistakes of others.

In this three-part article series, I will share with you some of the more prevalent reasons small businesses get into trouble and ultimately fail. In Part 1, we will examine money problems.


1. Undercapitalization.

Undercapitalization is, by far, one of the most common reasons small businesses get into trouble. It is a problem most frequently encountered by those who start their own business without any formalized business or financial training.

Frequently, these businesses are started by entrepreneurs that understand their chosen industry very well, have a good business concept, but lack the training and financial experience to understand how much capital will be required to make their business plan work. As a result, they struggle and never have enough capital to build their business properly. They end up ruining the company's and their own reputations before they ever have a chance to succeed.

This is a problem that is very easily avoided. The key is to hire the services of someone who has the skills the entrepreneur does not have personally, in this case, financial skills. A good CPA or other business consultant can provide the information and analyses to properly identify the level of capitalization required.

Many budding entrepreneurs want to avoid this up front cost, but it is a critical, and often fatal, mistake to do so. The capitalization required must be known before starting any new venture. Period. If it costs something to make this determination, so be it. It is necessary and there are no shortcuts.

2. Cutting the wrong costs.

When money gets tight, costs must be cut somewhere. Too many entrepreneurs resort to becoming tough on all expenditures and wind up cutting back across the board. They fail to realize that the ultimate solution is to increase sales and revenue and that cutting costs is only a temporary measure. Some costs are absolutely necessary to grow the business and cannot be cut.

For example, if you want to increase sales, you cannot cut marketing costs across the board. You can analyze marketing costs and cut those that do not work, (which should be done anyway), but overall spending on marketing should not decrease.

Costs that should be cut are those that represent excess and those that have little or no impact on sales efforts.

3. Resorting to high interest debt.

I've seen small business owners who resort to borrowing up to the credit limit on dozens of credit cards to finance their business. In fact, some acquire 20, 30 or more cards just for the purpose of funding "temporary" cash shortages.

Credit cards aren't the only high interest debt instruments entrepreneurs will resort to either. There are any number of lenders out there who will provide extremely high interest debt to small businesses in trouble.

Very few small businesses can afford to pay 18 to 21 percent interest on borrowed funds. Once this type of borrowing has occurred, the end is usually near and the owner has not only destroyed his business, but his own credit is ruined as well.

4. Inability to honor vendor credit terms.

Vendor credit terms are one of the best financing techniques available to any business. It allows the business to match the payment for goods sold to the receipt of funds from the selling of the goods so the business is never out-of-pocket during the sales cycle.

Consider the flip side, however. If the business has to pay for goods up front and wait possibly 30 to 60 days to complete the sales cycle and receive payment, it becomes very difficult for the business to expand sales. In fact, the business would begin to contract.

For this reason, vendor terms must be honored always. A small business cannot afford to be without this type of financing. Having vendors switch your account to COD is often the first nail in the coffin.

5. Borrowing from the government. Illegally.

Most small businesses in trouble simply cannot resist this one. Taxes withheld from employees and sales taxes collected from customers are not paid when due because there is no one sending dunning letters to collect these taxes. It takes the government longer to become aware of the underpayment or lack of payment, and we all know the squeaky wheel gets the grease. So tax monies are used to pay other expenses.

The entrepreneur must understand that these funds are not theirs! Withheld taxes are trust fund items. Sales taxes are collected as an agent for the state. Use of these funds for other purposes is a crime and will be dealt with severely. The IRS has put many companies out of business over trust fund taxes. States pursue misappropriation of sales taxes as theft, and it usually requires only a small amount of taxes stolen to qualify as a felony ($300 in Florida, for example).

While this type of "loan" is the easiest to obtain, it must never, ever be done.

Next week in Part 2 we are going to look at strategic problems that get small businesses into trouble.

Copyright (c) 2002

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